Many founders don’t consider this one until it’s too late. The excitement and adrenaline of getting started leads to a “kumbaya atmosphere” where all things are equal. This spills over into salaries. Sooner or later, the amount of time, effort and energy expended by the partners is no longer equal, but their salaries are. Tensions begin to rise.
Part 3 in our series titled, “Your partnership will fail!“
Over time, the amount of time and effort required of the partners to sustain your business startup will change. There are many diverse reasons for this:
- Loss of interest
- Loss of energy
- Satisfied with achievements
- Other initiatives
This disparity in time, rightly or not, is viewed as a lack of commitment between partners. The sense of injustice swelling from this is at the root of most broken partnerships. Sadly, this can easily be avoided when dealt with during the organization of your company structure. The answers gathered from these basic questions will lead you to the development of a Partner Salary Agreement to guide you through troubled times and potentially avoid some of them completely.
4 Questions to Guide Your Partner Salary Agreement Discussions
1. Should the Partners have a salary at all?
The answer is probably, “Yes” because most partners are also playing a key role in the ongoing operations of the company. For this reason, I encourage you to view the potential salary of of all Partners as two distinct parts, owner salary and employee salary. Doing this allows you to separate entitlement wages from earned wages. The approach leads to additional questions.
Sweat Equity – Clarity Helps Protect Startup Businesses
2. Should the partners receive an Ownership Salary (entitlement wages)?
This is a base amount of direct compensation paid to partners regardless of their ongoing contribution to the daily operations of the organization. Reasons for doing this include:
- Allows participation in company benefits program (i.e. insurance, 401k, etc.)
- Recognizes the legacy of the company’s founders
There are also several reasons you may consider eliminating Ownership Salary from your organization:
- Outside investors are likely to frown on this
- Increases the employee tax contributions of the company
- Depending on your state’s tax laws, you will likely net less from direct compensation than you would from a solid distribution plan
If you choose to constitute an Ownership Salary, keep it minimal. You do not want to strap the future of your organization with misguided commitments made today.
If you choose to eliminate an Ownership Salary, it’s still worth clearly acknowledging this as a conscious choice among partners, removing thoughts of entitlement and agreeing that the success of the company will directly affect the financial success of the partners and investors through profit distributions.
3. Should the partners receive an Employee Salary (earned wages)?
This is a base amount of direct compensation paid to partners based on their ongoing efforts in the daily operations of the organization. This questions is easily answered through the answer to a follow-up question: If this partner left the organization, would we have to hire someone to replace them?
- “Yes” – The partner is also filling the role of “employee” and should be compensated as such.
- “No” – The partner should not receive an Employee Salary.
4. What should the Employee Salary of a partner be?
The basis for answering this question is simple, the number itself will require a little research. Ask yourself, what would it cost to fill this position with another direct hire or contract resource? Several factors to consider are:
- What is the market currently paying for a similar position?
- How much experience does the partner have in this area of competency?
- Is the partner effective in this role?
- How easily could the role be filled if vacated by the partner?
The answers to these questions will result in a Partner Salary Agreement for your organization. There are no always right answers. You may not even formally document your Partner Salary Agreement. The most important thing is that you put these questions on the table and have the discussion.
Protect your organization; protect yourself – discuss the formula for partner salaries during the formation of your business startup!
Your Partnership Will Fail! continued…
Part 4 – Buy – Sell Agreement: What, Why, and How?